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A bear market

The world’s three biggest domestic bond markets all have special categories for foreign issuers: Yankees in the US, Samurais in Japan and Pandas in China. And in China’s case, they have proved to be as rare as the bear they are named after.

Issuance has never really gotten off the ground since HSBC and Bank of China reopened the market in September 2015 with their respective Rmb1 billion offerings. The following year, it did look as if the market might be starting to find its feet after issuers raised Rmb128 billion ($18 billion) via 46 deals. However, only 10 of those transactions were by genuine foreign borrowers, such as the World Bank and the Republic of Poland. The rest were largely Chinese property companies using their offshore vehicles to raise funds onshore.

Then in 2017, issuance nosedived to Rmb56.9 billion. The few bonds that came to market were very much symbolic in nature. A Belt-and-Road Panda by Maybank and another by the Republic of Hungary both debuted in July to mark the launch of Bond Connect, the trading mechanism which allows foreign investors to trade bonds through their offshore brokers in Hong Kong.

Activity has only marginally picked up this year, with issuance totalling Rmb71.9 billion by the end of September. But that may be about to change after the Chinese government recently announced new guidelines to liberalise the market.

Specifically, the People’s Bank of China (PBoC) has scrapped its requirement that prospective issuers obtain two credit ratings, one of which must be from a Chinese agency. Issuers likewise no longer need to have invested $1 billion onshore. Instead, they have to be able to show a minimum paid-in capital of Rmb10 billion and a three-year track record of profitability.

Wang Qing, an analyst at domestic rating agency Oriental Jincheng, told National Business Daily that the move “represents an important milestone in the internationalisation of the market”. He now predicts Panda issuance of Rmb100 billion in 2019.

This level would still represent a tiny fraction of the market’s overall Rmb83 trillion in outstanding bonds. But it demonstrates intent and follows other moves to encourage more two-way flows and foreign engagement.

In late August, for example, the government took three steps that fulfil the criteria for government and policy bank bonds to be included in the Bloomberg Barclays Global Aggregate Index. The first was the introduction of a real-time delivery-versus-payment settlement system through Bond Connect. The second adjustment was to allow block trading and the third was a three-year exemption covering income and value-added taxes on the interest income generated by foreign investors’ bonds.

As a result, China will be included in the index from next April, resulting in roughly $137 billion of inflows once the country reaches its full 5.49% weighting after a 20-month scaling-in period.

Over the next five years, up to $1 trillion could flow into China’s domestic bond market, particularly if the country is included in other key indices such as the FTSE World Government Bond Index and JPMorgan Government Bond Index. HSBC calculates that a 5% weighting in the former and a 10% weighting in the latter could generate inflows of $150 billion alone.

Where Panda bonds are concerned, issuers are almost certainly hoping for further rules changes that bring the market into line with international norms. One concerns market timing. The world’s most sophisticated borrowers typically issue as and when they spot a market window. Issuance is unlikely to scale up rapidly until China’s approval regime loosens further.

Issuers are also looking for better hedging instruments and a deeper swap market as it is still expensive to swap proceeds out of renminbi to other currencies beyond a three-year duration.

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